Look through the spin - The economy remains mired in an income recession

Predictably, the Prime Minister and Treasurer spun a positive narrative around the recently released National Accounts in Question Time on Wednesday.  The Prime Minister noted that real GDP expanded by 0.6% in the December quarter and by 3% over the year, and indicated that the economy remains in transition following the end of the boom in resources capital investment, and that household consumption and housing investment helped to boost growth. 

It is early days for Mr Scott Morrison in his new portfolio, but the Treasurer looked out of his depth in Question Time.  Mr Turnbull is far more effective in framing and articulating a vision and narrative for the economy.  The Prime Minister might well be the best Treasurer that Australia never had.

The Opposition was more interested in interrogating the Prime Minister over the alleged leaking of defence related classified material.  In so doing, Evidente believes it missed a valuable opportunity to question the Prime Minister and Treasurer about the fact that the economy remains stuck in an income recession.  The National Accounts revealed that the nominal GDP expanded by 1.8% in 2015, which represents the worst calendar year outcome since 1992.  Even during the depths of the financial crisis, the nominal economy managed to expand by 2% in 2009 (see chart). 

The distinction between real GDP - the set of accounts that most economists and commentators focus on - and nominal GDP is important.  Real GDP represents the flow of production in volume terms and therefore adjusts for inflation.  If the same volume of coal is produced across two quarters for instance, this translates into zero growth in real terms.  But if the coal price fell by 10% in the second quarter, this would translate into a nominal decline of 10%.

Nominal GDP represents the dollar value of the flow of production, and thus includes both volume and price effects.  Conceptually, it is equivalent to summing up growth in real GDP, domestic inflation and the terms of trade (the ratio of export to import prices).

The industry's focus on real GDP in the National Accounts probably is a legacy from earlier decades of variable inflation.  But Australia has now had low and stable inflation for three decades now.  Nominal GDP offers a more accurate perspective on the income flows of households and businesses; after all, workers earn nominal wages and businesses do not generate inflation adjusted cash flows.  It is little surprise then that persistent weakness in consumer and business sentiment surveys over the past four years have coincided with drop in nominal GDP growth. 

The fact that nominal GDP has grown well below 4% pa since 2012 confirms that the economy has been stuck in an income recession for four consecutive years.  Of course, the end of the commodities boom has underpinned this outcome.  The drop in the terms of trade by over one-third since 2011 has clearly provided the basis for the RBA's prolonged easing cycle, particularly at a time when the much anticipated handover from mining to non-mining business investment has failed to emerge.

The National Accounts bear this out, with private business investment detracting more than 1 percentage point from nominal GDP growth in 2015, while net exports detracted 1.5 percentage points (see chart).  In contrast, the interest sensitive sectors continue to support nominal GDP growth; household consumption and dwelling investment contributed more than 3 percentage points to growth.  The public sector also made a strong positive contribution. 

As per Evidente's previous post, the capex cliff evident from the ABS survey of capex intentions suggests that the drag from private business investment is expected to persist for the next 18 months.  Against this backdrop, the RBA will have little choice but to keep interest rates low for an extended period, and likely deliver two more rates over the course of 2016.